# Capital Structure Case Essay

Words: 1145
Pages: 5

Team D

Hi everyone,   Here is our week 4 assignment. I highlighted how I propose we split up this assignment. Each section should be about 150 - 200 words.    Resource: Evaluating McGraw Industries’ Capital Structure Case in Ch. 11 of Principles of Managerial Finance
Write a 350- to 700-word memo to the president of McGraw Industries that responds to questions in the case.
Explain how the cost of debt, cost of equity, and weighted average cost of capital are determined.
Cost of debt is simply the weighted rates of interest paid by the company on its debts. However, cost is equity is not so straightforward. The cost of equity is based on an estimate of a reasonable rate of return on the shareholders' investment. The term ‘reasonable’
Compile all sections into a Memo format, revise, submit to writepoint and plagiarism checker and make changes, and submit with document of originality.
WACC = D/(D+E) X Kd X (1-T) + E/(D+E) Ke
D/(D+E) = Proportion of debt
E/(D+E) = Proportion of equity = 1- Proportion of debt
We are given the following Capital structurea | Source of capital | Current (10% debt) | A (30% debt) | B (50% debt) | Long-term debt | \$1,000,000 | \$3,000,000 | \$5,000,000 | | Coupon interest rateb | 9% | 10% | 12% | Common stock | 100,000 shares | 70,000 shares | 40,000 shares | | Required return on equity, ksc | 12% | 13% | 18% |

Current
Kd = 9%, D/(D+E) = 10%, Ke= 12% , E/(D+E) = 1-10%=90%
WACC = 10% X 9% X (1-0.4) + 90% X 12% = 11.34%

Alternative A
Kd = 10%, D/(D+E) = 30%, Ke= 13% , E/(D+E) = 1-30%=70%
WACC = 30%X10%X(1-0.4) + 70%X13% = 10.9%

Alternative B
Kd = 12%, D/(D+E) = 50%, Ke= 18% , E/(D+E) = 1-50%=50%
WACC = 50%X12%X(1-0.4) + 50%X18% =12.60%

TO: President of McGraw Industries
FROM: CFO, Ron Lewis
DATE: November 14, 2010
SUBJECT: Capital Structure